Difference between Fundamental and Technical Analysis, SAPM Notes

Difference Between Fundamental and Technical Analysis
Unit 1 SAPM Notes 
Concept of Investments

Meaning of fundamental analysis

Fundamental analysis is method of finding out the future price of a stock which an investor wishes to buy. Fundamental analysis is used to determine the intrinsic value of the share of a company to find out whether it is overpriced or under priced by examining the underlying forces that affect the well being of the economy, Industry groups and companies.

Fundamental analysis is simply an examination of future earnings potential of a company, by looking into various factors that impact the performance of the company. The prime objective of a fundamental analysis is to value the stock and accordingly buy and sell the stocks on the basis of its valuation in the market. The fundamental analysis consists of economic, industry and company analysis. This approach is sometimes referred to as a top-down method of analysis.

Meaning of technical analysis

In fundamental analysis, a value of a stock is predicted with risk-return framework based on economic environment. An alternative approach to predict stock price behaviour is known as technical analysis. It is frequently used as a supplement rather than as a substitute to fundamental analysis. Technical analysis is based on notion that security prices are determined by the supply of and demand for securities. It uses historical financial data on charts to find meaningful patterns, and using the patterns to predict future prices.

In the words of Edwards and Magee: “Technical analysis is directed towards predicting the price of a security. The price at which a buyer and seller settle a deal is considered to be the one precise figure which synthesizes, weights and finally expresses all factors, rational and irrational quantifiable and non-quantifiable and is the only figure that counts”.

Difference between technical and fundamental analysis

The key differences between technical analysis and fundamental analysis are as follows:

1.       Technical analysis mainly seeks to predict short term price movements, whereas fundamental analysis tries to establish long term values.

2.       The focus of technical analysis is mainly on internal market data, particularly price and volume data. The focus of fundamental analysis is on fundamental factors relating to the economy, the industry, and the firm.

3.       Technical analysis appeals mostly to short-term traders i.e. speculators, whereas fundamental analysis appeals primarily to long-term investors.

4.       Technical analysis is the a simple and quick method on forecasting behaviour of stock prices. Whereas, fundamental analysis involves compilation and analysis of huge amount of data and is therefore, complex, time consuming and tedious in nature.

5.       The technical analysis is based on the premise that the history repeats itself. Therefore, the technical analysis answers the question “What had happened in the market” while on the basis of potentialities of market fundamental analysis answers the question, “What will happen in the market”.

6.       The technical analysis assumes that the market is 90 percent psychological and 10 percent logical, while the fundamental analysis believes that the market is 90 percent logical and 10percent psychological.

7.       The technical analysis seeks to estimate security prices rather than values, while the fundamental analysis estimates the intrinsic value of a security.

8.       According to technical analysts, their method is far superior than the fundamental analysis, because fundamental analysis is based on financial statements which themselves are plagued by certain deficiencies like subjectivity, inadequate disclosure etc.